Monthly Archives: June 2018

The Destructive Pooling of Risks and Outcomes

29 Friday Jun 2018

Posted by in Health Insurance, Obamacare, Uncategorized

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Forcing health insurers to cover pre-existing conditions at standard rates is like asking home insurers to cover homes in flood plains at standard rates. If the government says home insurers must do so, standard rates will rise as well as the cost of homeownership. Lenders generally won’t accept homes as collateral unless they are adequately insured against flooding, and by raising the cost of insurance, the government requirement that all must share in the burden of high flood risk would discourage homeownership generally. But you’ll get a break if you’re in a flood plain! Coercive government regulations like rate regulation and coverage mandates have destructive (but predictable) consequences.

The difference between flood plains and health conditions is that sooner or later, a lot of us will be burdened with the latter. The trick is to get underwritten for health insurance before that happens. If the government says that health insurers must offer standard rates to those already afflicted with serious health conditions, à la Obamacare, standard rates will rise, which will induce some potential buyers to opt out. In fact, it will lead the youngest and healthiest potential buyers to opt out. This is the genesis of the so-called insurance death spiral.

Some then ask why the government shouldn’t prevent opt-outs by requiring all individuals to carry health insurance… an individual mandate. Perhaps doubling down on government coercion via compelled coverage might rectify the ill effects of rate regulation. However, requiring low-risk individuals to pay rates that exceed their willingness to pay cross-subsidizes individuals who belong in a different risk pool. Aside from it’s doubtful constitutionality and infringement on individual liberty, this policy forces low-risk individuals to insure and pay as if they are high-risk, and high-risk individuals to pay as if they are low risk, and it leaves the task of pricing to the arbitrary decisions of bureaucrats. It may also lead to massive distortions in the use of medical resources.

Direct Subsidies Are Better

There is a better way to provide coverage for individuals with pre-existing conditions, one that does not destroy the risk-mitigating function of health insurance markets. High-risk individuals can be covered through a combination of self-paid standard premiums and a direct public subsidy that does not distort the market’s social function in pricing risk. Such a subsidy would be funded by individuals in their roles as taxpayers, not as premium payers. Now, I’m the last person to advocate big-government solutions to social and economic problems, but this approach requires only that government serve as a pass-through entity. Government need not play any role in providing or regulating health care, and it should not interfere with the pricing of risk in private markets for health insurance.

Insurability Protection

The high-risk segment’s reliance on subsidies can be minimized over time with certain innovations. In particular, healthy individuals should be able to purchase riders protecting their future insurability at standard rates. Their premium would include a component reflecting the discounted expected costs of developing health conditions in the future. The additional premium could even be structured as level payments over time. People will develop health conditions, of course, a few much sooner than others, but without an incremental impact on their future premiums, as the additional risk  would be covered by the cost of the rider for future insurability.

To see how the situation would evolve, suppose that the standard risk pool includes everyone free of pre-existing conditions, young and old, with guaranteed future insurability. The high-risk segment is already afflicted with conditions and mostly reliant on the direct subsidies discussed above, but that segment will shrink over time as the population ages and mortality takes its toll. Therefore, the proportion of individuals reliant on subsidies will decline. Meanwhile, the standard risk pool transforms into a combination of healthy and sick, but it is actuarily sustainable without subsidies. Of course, some fraction of individuals will always be born with serious health conditions, though one day prospective parents could conceivably purchase future insurability protection for their children at conception… well, perhaps just a little after. The point is that the initial level of subsidies should be transitional. For a permanently small share of individuals, however, it will be a part of the social safety net.

To extend the foregoing, there is considerable latitude in the composition of “standard risks” and the willingness of individual buyers to pay premiums that might reflect interpersonal differences. For example, individuals should be free to self-insure, foregoing participation in the insurance market altogether. If they do so, the insured risk pool will e of lower quality. Some people might prefer to purchase insurance covering catastrophic health events only, paying for health maintenance out-of-pocket as well as care for conditions less immediately threatening. Health maintenance is not really a risk anyway, but more of a constant, so excluding it from insurance contracts is sensible. In fact, less “comprehensive” insurance coverage keeps the cost of coverage down, encouraging wider participation and enhancing the quality of the risk pool.

Mandates

These insurability riders might not accomplish much under a regime of mandated comprehensive benefits. That would increase the cost of coverage as well as the cost of the insurability rider, making it more likely that healthy individuals would opt-out. That brings us back to the “elephant in the room”: whether a so-called individual mandate is required to ensure that 1) the “standard” risk pool is of high quality; and 2) the uninsured don’t “free-ride” by capturing the public subsidy once their health deteriorates for any reason. But again, the availability of less comprehensive coverage will keep premiums low and help to accomplish both objectives. Moreover, free-riders whose health fails could always be denied the public subsidy if they had been uninsured over a period of any length prior to their diagnosis. That would leave them with several less attractive alternatives: pay high-risk-pool premiums out of their own pockets, or rely on assistance from family, friends, charitable organizations and providers.

Dumb Intervention

Requiring insurers to cover pre-existing health conditions at standard rates is destructive to insurance markets. It imposes liabilities for more certain, costly events in a market for which sustainable operation depends on the pooling of events of similar risk. It harms consumers directly by increasing the cost of mitigating those risks. It worsens the uninsured free-rider problem, causing additional deterioration in the risk pool and adding more cost pressure. It also may lead to increases in out-of-pocket deductibles and copayment rates as insurers attempt to manage high claim levels. And it invites further regulatory intervention, as policymakers engage in misguided attempts to “fix” problems created by the original intervention (while blaming the market, of course).

A further question is whether the alternative I have outlined would involve federal subsidies or state outlays funded in part by federal block grants. I prefer the latter, but either way, it is less costly and distortionary to pay for insuring against the costs of pre-existing conditions via direct subsidies to needy individuals as part of the social safety net than by destroying insurance markets.

Monstrous Mathematics: Selling Abortion As Fiscal Austerity

27 Wednesday Jun 2018

Posted by in Abortion

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The pro-choice Left says, “Massive welfare benefits will be necessary to support the babies you’d force women to carry to term.” The remark is viewed as an argument clincher among pro-choicers, but it’s not a persuasive defense of abortion rights. In fact, it’s quite beside the point: human lives are at stake. The “welfare defense” suggests that there must be a valid tradeoff between public aid and lives that can otherwise be saved. Or indeed, between publicly-funded abortions and future public aid. By that logic, perhaps EMS service should be suspended in impoverished neighborhoods so that welfare payments might be reduced. These kinds of monstrous tradeoffs are not remotely on the table.

(The commentary that follows does not pertain to abortions that might be necessary to preserve a woman’s life or health, or in the case of pregnancies caused by rape.)

An operative assumption underlying the left’s suggestion is that additional human lives are problematic (or at least problematic for certain groups). There are two ways to think about this:

First, a single woman might have strong misgivings about the prospects of a child for economic reasons, or for fear of social ostracism; even couples can find a child economically burdensome. Fair enough. We won’t get into questions about personal responsibility. But leftists, under the spell of scientism, collectivism, and with more than a little hubris, insist there is no choice but for government to care for unaborted human beings and their families. They have devoted little thought to the reality that government programs intended to benefit the poor have in fact led to the disintegration of family units, a deteriorating housing stock, an explosion of the prison population, poorly functioning labor markets, and a cycle of mass dependency. But statists have not completely destroyed private institutions that can and do play a crucial role in helping impoverished new parents. That includes adoption agencies, churches, fraternal organizations, private charities, and free markets. These actors and institutions do not require any form of central planning by government.

Second, the Left holds that human beings are a burden on resources and a threat to “sustainability”. This is fundamentally incorrect. The world’s population has grown dramatically over the past several hundred years (from 0.9 billion in 1800 to 6.1 billion in 2000) while average income has increased much more dramatically (from less than $1.2 trillion in 1800 to $63.1 trillion in 2000). Humans are problem solvers, not problem makers, when they are free to create, produce, and take ownership in their surpluses. In fact, human ingenuity is the most critical renewable resource of all.

The abortion issue will not be settled on economic grounds. A plurality of adults in the U.S. believe that ending a pregnancy in its earliest stages is not murder, according to a recent Gallup poll. As I’ve argued in other contexts, bad or counter-productive laws are usually characterized by a lack of consensus in the general population over the question at issue. They are counterproductive because non-compliance leads to underground activity and unintended consequences. That’s true of prohibitions on alcohol, drugs and prostitution, and in the case of abortion, considerably greater danger may come to those seeking the services of an illegal abortionist. There is a fairly strong consensus, however, that late-term abortions should be illegal (see the link provided above). Unfortunately, the 20% that approve of late-term abortions is still rather significant.

The 80% share disapproving of late-term abortion corresponds roughly to the notion of fetal viability. At the time of the Roe v. Wade Supreme Court decision in 1973, viability was said to be reached between the 24th and 28th week of pregnancy. Technology shortened that time to less than 24 weeks, however, as the Court recognized in Planned Parenthood v. Casey in 1992. Some believe that the time to viability could be reduced much more with the development of artificial womb technology. That will upend the abortion debate, not only on account of challenges to the legal definition of viability, but because it will give expectant mothers an earlier alternative to terminating the life of the fetus. While artificial wombs might raise other ethical issues, I view the impact on the abortion debate as unambiguously positive.

Fetal viability does not offer much satisfaction to those whose views on abortion are heavily influenced by religion. Many Buddhists, Catholics, Eastern Orthodox Christians, Evangelical Protestants, and Orthodox Jews believe that life begins at the moment of conception; abortion is forbidden among Sikhs. (See this discussion for more detail.) Hindus often believe that personhood develops beginning at three months, while Islam teaches that life begins at about 120 days (though there is variation down to as little as seven weeks). On the other hand, Methodists, Presbyterians, Reform and Conservative Jews, Unitarians and Wiccans all support abortion rights, as do many (but not all) atheists and the strictly non-religious. It’s a safe bet that most of the world’s population affiliates with religions that either forbid abortion or believe in limits on the stage of pregnancy at which abortion is permissible. None of these distinctions is without exception, however. After all, there are many pro-choice Catholics, and abortions occur even in the Indian Sikh community.

Fetal viability at least provides something approximating an objective standard in the legal debate and prevents all but a small percentage of late-term abortions. Neither pro-choice nor pro-life activists will ever be satisfied with a given definition falling short of their respective ideals. Economic tradeoffs, however, have nothing to do with the pro-life position. Neither do cost-benefit calculations as the basis of public funding of abortions. Abortion advocates attempt to marshal its presumed economic benefits, but the effort smacks of the worst excesses of eugenics.

Exposing Children To Risk at the Border

19 Tuesday Jun 2018

Posted by in Immigration

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Unaccompanied children (UACs) will be housed in temporary quarters at the border even in the wake of President Trump’s new executive order intended to end family separations. That order began the process of reuniting children and parents that were separated under the Administration’s earlier effort to discourage the recent deluge of illegal immigrants claiming asylum. But UACs were the original subject of the so-called Flores Consent Decree in 1997, which limited the length of a minor’s stay in a holding facility to 20 days before placement with a relative, other guardian, or foster shelter. Soon after, the decree was extended to accompanied children by a federal court.

There is no doubt that all of these minors are much safer in holding facilities than during their dangerous attempts to cross the border through rough, arid country, and perhaps over the Rio Grande. That seems rather obvious, and the geography isn’t the worst of it: UAC’s are highly likely to become victims of human trafficking, which runs rampant along the U.S.-Mexican border.

UACs have already separated from their families, deliberately or otherwise, before their journey north. But a family embarking on such an odyssey is likewise exposed to tremendous danger from physical hazards and criminal predation, and the children are more likely to be young. If detained by U.S. border security, they might be about as safe or safer in custody than they’ve ever been, given the lawlessness at many points of departure in Central America.

For these and other reasons, whether children should ever be separated from parent(s), or someone claiming to be a parent(s), is not as straightforward as many have suggested. The recent outrage over the treatment of immigrant children at the border is based on a number of misapprehensions. I attempt to address some of these in the points below:

>>Prior to President Trump’s executive order last week ending family separations, 10,000 (more than 80%) of the children housed by the U.S. government at the border were actually UACs, separated from their families before their journeys ever began, not after apprehension at the border. Most but not all of these kids are teenagers delivered into the hands of smugglers, who sometimes collect a premium on their charges via misuse and sexual abuse. Here is part of a statement from Kristjen Nielsen, Secretary of Homeland Security:

“The vast, vast majority of children who are in the care of HHS right now, 10,000 of the 12,000, were sent here alone by their parents. That’s when they were separated. So somehow we’ve conflated everything but there’s two separate issues. 10,000 of those currently in custody were sent by their parents with strangers to undertake a completely dangerous and deadly travel alone.“

>>2,000 (less than 20%) of the children housed by HHS were separated from their parents when the parents claimed asylum after attempting to cross illegally. However, a consequential share of those children were not biologically related to the supposed parents after all; some UACs are used by coyotes to pose as the children of adult immigrants, and vice versa, so that they all gain more favorable treatment if apprehended.

>>The ranks of “asylum seekers” have swollen by attempts to migrate for economic reasons. A preference for an illegal crossing is presumptive evidence that this is the case. Here is more from Nielsen:

“… in the last three months we’ve seen illegal immigration on our southern border exceed 50,000 people each month, multiples over each month last year. Since this time last year, there has been a 325 percent increase in unaccompanied alien children and a 435 percent increase in family units entering the country illegally. …Over the last ten years, there has been a 1700 percent increase in asylum claims, resulting in asylum backlog of 600,000 cases.“

>>Enforcing the Flores Consent Decree makes it almost impossible to meet the goals of 1) properly adjudicating an asylum claim by a parent detained after an illegal crossing, and 2) keeping the family together. As a result, before April of this year, prior to the Trump Administration’s effort to discourage frivolous claims, the reality was that most “credible fear” asylum claims at the border resulted in the immediate release of families.

>>Many of the separated children arrived with single parents, including female children with fathers. In fact, most illegal immigrants are male and mostly unaccompanied by children. Ensuring the safety of children is a challenge in any detention environment. Here is what Human Rights Watch‘s 1999 Report on Children’s Rights had to say on the matter:

“Despite the directive of Article 37(c) of the Convention on the Rights of the Child that “every child deprived of liberty shall be separated from adults unless it is considered in the child’s best interest not to do so,” children continued to be held with adults in many parts of the world. Human Rights Watch opposed the commingling of children and adults in detention because contact with adults was almost never in the children’s best interest. Children in adult facilities rarely received educational and vocational training appropriate to their needs. detention because contact with adults was almost never in the children’s best interest. Children in adult facilities rarely received educational and vocational training appropriate to their needs.”

None of this is easy. It is arguably prudent and in a child’s best interest to keep them housed separately from adults. The unfortunate reality is that the recent surge of illegal entrants cited by HSA Secretary Nielsen has placed a strain on existing facilities. However, assuming that family relationships can be verified, the designation of facilities for families-only would offer an alternative that has been lacking.

>>Ultimately, the border control separated detained “parents” from children at the volition of the parents. The parents were offered the opportunity to take their children back across the border, where they could head to an official port-of-entry to claim asylum. Of course, an asylum claim after an illegal crossing involves a lengthy delay. (And an attempt to re-enter illegally is a felony, which would all but guarantee separation.) Under Trump’s policy, if the parents refused to go back in the first instance, claiming asylum immediately, they were separated from their children until their cases were adjudicated. But after 20 days, the children must be transferred to a foster shelter, relative, or family friend in the U.S.

>>Legitimate asylum-seekers have alternatives to risky illegal crossings. They should go to a port of entry to claim asylum, not expose their children to a long, hazardous slog through the marchland. And many do, as this article makes clear. There are 50 ports-of-entry along the U.S. Mexican border.

>>The claim that UACs and children separated from their apparent guardians were mistreated has been accepted uncritically by the media. The shelters run by the Department of Health and Human Services (HHS) are not Auschitz, but you’d ever know it from listening to many news sources. The immigrants are provided with food, medical care and sanitary conditions far better than they may have ever experienced. References to Nazi Germany and the Holocaust are so shockingly off-base as to constitute a denial of the seriousness of the Holocaust.

>>The U.S. government is within its powers to regulate immigration, according to the Supreme Court’s ruling in Chy Lung v. Freeman (1875). That decision turned on the Article 1 Commerce Clause, which gives Congress the power to regulate commerce with foreign nations. The Court ruled that this applies to immigration, a practical solution to the conflicting and sometimes highly restrictive state regulations on immigration in place at the time.

My position is that U.S. citizens hold the right to freedom of association, which includes the right to exclude. In that sense, citizenship is a “club good”. Yes, such legal exclusions are binding on citizens who disagree, like most other laws, unless they emigrate, but such a policy does not prohibit travel abroad, foreign travelers, and guest workers. Immigration controls should be calibrated such that inflows meet the country’s economic needs and do not place an undue burden on public finances. I also support generous allowances for legitimate asylum seekers, subject to vetting. As for the surge in the number of immigrant families detained by border control, more facilities that are specifically designed to house families may be required. Finally, Congress must find a compromise to the issues of Deferred Action on Childhood Arrivals (DACA), border security, and eliminating the Flores Decree. There are avenues for a compromise solution, but raw political motives seem to be keeping Democrats away from the table.

Portugal’s Successful Détente With Drug Users

14 Thursday Jun 2018

Posted by in Liberty, Prohibition, War On Drugs

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The U.S. wastes vast quantities of resources on the War on Drugs with nothing to show for it but counterproductive results. Drug use today is as commonplace as ever, despite the cumulative expenditure of many billions of dollars on law enforcement and judicial costs. We have ceded drug markets to organized crime, tolerated corruption of public officials, incurred the human and economic costs of millions of life-years wasted behind bars, and subjected users to impure and dangerous forms of contraband. And in the process, we have encouraged addiction, disease and death while dedicating relatively few resources to programs that might have helped these troubled souls.

Contrast that with Portugal’s approach to drug policy. The country’s decriminalization of drug use as well as harm reduction and treatment programs both deserve consideration in this context. Decriminalization took place in 2001: drugs are still illegal, but the penalties are very light. Treatment programs include a system of needle exchanges beginning in the early 1990s as well as various forms of outreach instituted in 2003-2005. Before the advent of these policies, Portugal had an extremely high rate of drug abuse; many feared that decriminalization would lead to further degeneracy, but no increase in drug use transpired, and the liberalized policies are credited with a drastic reduction in drug deaths and other tragic fallout. Consider the following:

  • a dramatic decline in the number of people who died from using an illicit drug to a rate of drug-induced death well below the EU average;
  • newly-diagnosed HIV cases among intravenous drug users fell by more than 95%;
  • drug-offenses declined by about 2/3;
  • the proportion of offenders imprisoned for offenses under the influence of drugs fell in half;
  • With the exception of cannabis, estimates of drug use among 15-34 year-olds have decreased, with lifetime and recent use rates below EU averages;

These facts are taken from this discussion of the effects of Portugal’s drug policies, this Wikipedia entry, and the 2018 Portugal Country Drug Report from the European Monitoring Centre for Drugs and Drug Addiction.

As a fiscal matter, some of the strongest objections to Portuguese drug policy have to do with the granting of public aid to drug addicts, who usually have themselves to blame for their predicament. And in fact, decriminalization was accompanied by a decision to transfer funds associated with enforcing drug laws and punishing offenders into treatment and rehabilitation of addicts. This includes subsidized housing and jobs as well as loans for certain productive efforts. These strike me as better uses of public funds than a drug war, and by all accounts the programs have been successful. And to the extent that recovered addicts are able to lead productive lives, they add to the strength of Portugal’s economy. In an ideal, classically-liberal order, privately-funded lifetime insurability would avoid the need for public funding of these programs, but that is a reform for another day.

Like any prohibition of activity in which a plurality engages, laws against drug use are generally ineffective and counterproductive (also see here). Portugal’s enlightened approach to drug policy is praiseworthy, sets a great example for other countries, and might be more politically feasible than full legalization. However, as long as there are any penalties for drug possession, there will be a wedge through which rents can be extracted by the underworld. Full legalization would do the most to attenuate crime and other risks associated with drug use, and it would also maximize the resources available to address problems faced by addicts and drug-dependents.

Note: the poster above is from 2014… the numbers are larger now!

Don’t Worry: Your IOUs To Yourself Are In a Trust Fund!

10 Sunday Jun 2018

Posted by in Medicare, Social Security, Socialism

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The Social Security and Medicare trust funds should offer no comfort as the obligations of those programs outrace revenues. Between them, the funds hold about $3.1 trillion of federal government bonds purchased with past surplus “contributions” from FICA and Medicare payroll taxes. In other words, those surplus contributions were used to pay for past government deficits. Here’s what Warren Meyer has to say on the topic:

“Imagine to cover benefits in a particular year the Social Security Administration needs $1 billion above and beyond Social Security taxes. If the trust fund exists, the government takes a billion dollars of government bonds out and sells them to private buyers on the open market. If the trust fund didn’t exist, the government would …. issue a billion dollars in bonds and sell them to private buyers on the open market. In either case, the government’s indebtedness to the outside world goes up by a billion dollars.”

Therefore, the trust funds do not provide any real cushion against future obligations. As Meyer says, you can write IOUs to yourself, put them in a piggy bank and call it a trust fund of your very own, but that won’t increase your wealth.

As it happens, last week the Trustees of the Medicare (MC) Trust Fund released the latest projections showing that it will be exhausted by 2026. Likewise, the Trustees of the Social Security (SS) Trust Fund reported that it will be depleted by 2036. But again, those trusts do not enhance the federal government’s fiscal position, so they really don’t matter. Even with the interest earned on the bonds held in trust, which is itself owed by the federal government, the trusts are merely placeholders for an equivalent dollar value of unfunded federal obligations. And in a very real sense, these funds hold no more than our own future tax liabilities: that debt is our debt.

Federal spending on discretionary and other on-budget entitlements is deeply in deficit on an ongoing basis, expected to be greater than $1 trillion annually by 2020, according to the Congressional Budget Office. Then add the bonds that will be sold to the public from the SS and MC trust funds, and total government borrowing from “the public” will become that much larger. After the trust funds are exhausted, accounting for the impact of the annual SS and MC system deficits will be more transparent.

The previous use of SS and MC contributions to pay for other government outlays strikes many as a violation of trust. Remember, however, that contributions to these systems are taxes, after all. And despite apparent impressions to the contrary, and perhaps for worse, individual vesting was never part of the SS system. But if the government must borrow a dollar (on a unified basis), is it always better to do it later? That was essentially the decision made (repeatedly) when FICA and Medicare taxes were used to purchase government bonds. The answer depends on whether the government has an immediate uses for the surplus that can be expected to earn returns superior to investment opportunities of suitable risk otherwise available to the trust funds. I would argue, however, that most of the “spent” funds from surplus FICA and Medicare taxes were put toward government consumption, and much less to investment in physical or social infrastructure. In fact, the availability of the SS and MC surpluses probably encouraged that consumption. To that extent, it was a certainly a mistake.

If the question is at what point must the government address the shortfall in its ability to pay future obligations to seniors, the answer is not “2026 and 2034”. It is now. The programs are racking-up obligations to future retirees that will be impossible to meet. The long-run (75-year) SS deficit projected by the trustees has a present value of $13.2 trillion, with an annual deficit growing to about 1.5% of GDP. By then, the Medicare deficit is expected to bring the combined shortfall of the two programs up to 2.3% of GDP. The trustees estimate that SS benefits would have to be cut by 25% in order to eliminate that deficit, with additional cuts to Medicare.

Oh, but those estimates treat the trust funds as if they are meaningful assets, and they are not! Of course, there are other solutions to the funding shortfall, but I truly hope that current workers have realistic expectations. They should adjust their saving rates to avoid excessive reliance on government social and medical insurance programs.

Central Planning Fails to Scale, Unlike Spontaneous Order

05 Tuesday Jun 2018

Posted by in Central Planning, Markets, Price Controls

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The proposition that mankind is capable of creating a successful “planned” society is at least as old as the Bronze Age. Of course it’s been tried. The effort necessarily involves a realignment of the economic and political landscape and always requires a high degree of coercion. But putting that aside, such planning can never be successful relative to spontaneous order of the kind that dominates private affairs in a free society. The task of advancing human well-being given available resources has never been achieved under central planning. It always fails miserably in this regard, and it always will fail to match the success of decentralized decision-making and private markets.

There are various ways to explain this fact, but I recently came across an interesting take on the subject having to do with the notion of scalability. Francis Turner offers this note on the topic at the Liberty.me blog. To begin, he gives a lengthy quote from a software developer who relates the problems of social and economic planning to the complexity of managing a network. On the topic of scale, the developer notes that the number of relationships in a network increases with the square of the number of its “nodes”, or members:

“2 nodes have 1 potential relationship. 4 nodes (twice as many) has 6 potential relationships (6 times as many). 8 nodes (twice again) has 28 potential relationships. 100 nodes => [4,950] relationships; 1,000 nodes => 499,500 relationships—nearly half a million.“

Actually, the formula for the number of potential relationships or connections in a network is n*(n-1)/2, where n is the number of network nodes. The developer Turner  quotes discusses this in the context of two competing network management structures: client-server and peer-to-peer. Under the former, the network is managed centrally by a server, which communicates with all nodes, makes various decisions, and routes communications traffic between nodes. In a peer-to-peer network, the work of network management is distributed — each computer manages its own relationships. The developer says, at first, “the idea of hooking together thousands of computers was science fiction.” But as larger networks were built-out in the 1990s, the client-server framework was more or less rejected by the industry because it required such massive resources to manage large networks. In fact, as new nodes are added to a peer-to-peer network, its capacity to manage itself actually increases! In other words, client-server networks are not as scalable as peer-to-peer networks:

“Even if it were perfectly designed and never broke down, there was some number of nodes that would crash the server. It was mathematically unavoidable. You HAVE TO distribute the management as close as possible to the nodes, or the system fails.

… in an instant, I realized that the same is true of governments. … And suddenly my coworker’s small government rantings weren’t crazy…”

This developer’s epiphany captures a few truths about the relative efficacy of decentralized decision-making. It’s not just for computer networks! But in fact, when it comes to network management, the task is comparatively simple: meet the computing and communication needs of users. A central server faces dynamic capacity demands and the need to route changing flows of traffic between nodes. Software requirements change as well, which may necessitate discrete alterations in capacity and rules from time-to-time.

But consider the management of a network of individual economic units. Let’s start with individuals who produce something… like widgets. There are likely to be real economies achieved when a few individual widgeteers band together to produce as a team. Some specialization into different functions can take place, like purchasing materials, fabrication, and distribution. Perhaps administrative tasks can be centralized for greater efficiency. Economies of scale may dictate an even larger organization, and at some point the firm might find additional economies in producing widget-complementary products and services. But eventually, if the decision-making is centralized and hierarchical, the sheer weight of organizational complexity will begin to take a toll, driving up costs and/or diminishing the firm’s ability to deal with changes in technology or the market environment. In other words, centralized control becomes difficult to scale in an efficient way, and there may be some “optimal” size for a firm beyond which it struggles.

Now consider individual consumers, each of whom faces an income constraint and has a set of tastes spanning innumerable goods. These tastes vary across time scales like hour-of-day, day-of-week, seasons, life-stage, and technology cycles. The volume of information is even more daunting when you consider that preferences vary across possible price vectors and potential income levels as well.

Can the interactions between all of these consumer and producer “nodes” be coordinated by a central economic authority so as to optimize their well-being dynamically, subject to resource constraints? As we’ve seen, the job requires massive amounts of information and a crushing number of continually evolving decisions. It is really impossible for any central authority or computer to “know” all of the information needed. Secondly, to the software developer’s point, the number of potential relationships increases with the square of the number of consumers and producers, as does the required volume of information and number of decisions. The scalability problem should be obvious.

This kind of planning is a task with which no central authority can keep up. Will the central authority always get milk, eggs and produce to the store when people need it, at a price they are willing to pay, and with minimal spoilage? Will fuel be available such that a light always turns on whenever they flip the switch? Will adequate supplies of medicines always be available for the sick? Will the central authority be able to guarantee a range of good-quality clothing from which to choose?

There has never been a central authority that successfully performed the job just described. Yet that job gets done every day in free, capitalistic societies, and we tend to take it for granted. The massive process of information transmission and coordination takes place spontaneously with spectacularly good results via private discovery and decision-making, secure property rights, markets, and a functioning price mechanism. Individual economic units are endowed with decision-making power and the authority to manage their own relationships. And the spontaneous order that takes shape remains effective even as networks of economic units expand. In other words, markets are highly scalable at solving the eternal problem of allocating scarce resources.

But thus far I’ve set up something of a straw man by presuming that the central authority must monitor all individual economic units to know and translate their demands and supplies of goods into the ongoing, myriad decisions about production, distribution and consumption. Suppose the central authority takes a less ambitious approach. For example, it might attempt to enforce a set of prices that its experts believe to be fair to both consumers and producers. This is a much simpler task of central management. What could go wrong?

These prices will be wrong immediately, to one degree or another, without tailoring them to detailed knowledge of the individual tastes, preferences, talents, productivities, price sensitivities, and resource endowments of individual economic units. It would be sheer luck to hit on the correct prices at the start, but even then they would not be correct for long. Conditions change continuously, and the new information is simply not available to the central authority. Various shortages and surpluses will appear without the corrective mechanism usually provided by markets. Queues will form here and inventories will accumulate there without any self-correcting mechanism. Consumers will be angry, producers will quit, goods will rot, and stocks of physical capital will sit idle and go to waste.

Other forms of planning attempt to set quantities of goods produced and are subject to errors similar to those arising from price controls. Even worse is an attempt to plan both price and quantity. Perhaps more subtle is the case of industrial policy, in which planners attempt to encourage the development of certain industries and discourage activity in those deemed “undesirable”. While often borne out of good intentions, these planners do not know enough about the future of technology, resource supplies, and consumer preferences to arrogate these kinds of decisions to themselves. They will invariably commit resources to inferior technologies, misjudge future conditions, and abridge the freedoms of those whose work or consumption is out-of-favor and those who are taxed to pay for the artificial incentives. To the extent that industrial policies become more pervasive, scalability will become an obstacle to the planners because they simply lack the information required to perform their jobs of steering investment wisely.

Here is Turner’s verdict on central planning:

“No central planner, or even a board of them, can accurately set prices across any nation larger than, maybe, Liechtenstein and quite likely even at the level of Liechtenstein it won’t work well. After all how can a central planner tell that Farmer X’s vegetables taste better and are less rotten than Farmer Y’s and that people therefore are prepared to pay more for a tomato from Farmer X than they are one from Farmer Y.”

I will go further than Turner: planning can only work well in small settings and only when the affected units do the planning. For example, the determination of contract terms between two parties requires planning, as does the coordination of activities within a firm. But then these plans are not really “central” and the planners are not “public”. These activities are actually parts of a larger market process. Otherwise, the paradigm of central planning is not merely unscalable, it is unworkable without negative consequences.

Finally, the notion of scalability applies broadly to governance, not merely economic planning. The following quote from Turner, for example, is a ringing endorsement for federalism:

“It is worth noting that almost all successful nations have different levels of government. You have the local town council, the state/province/county government, possibly a regional government and then finally the national one. Moreover richer countries tend to do better when they push more down to the lower levels. This is a classic way to solve a scalability problem – instead of having a single central power you devolve powers and responsibilities with some framework such that they follow the general desires of the higher levels of government but have freedom to implement their own solutions and adapt policies to local conditions.”